Consider a put option on a stock with exercise price K = $90 and maturity T...

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Consider a put option on a stock with exercise price K = $90 and maturity T - 1 year. The stock's current price is S = $100, the volatility is o = 20%, and the dividend yield is q = 3%. The risk-free rate is Rp = 2%, and the expected (price) return of the stock is μ = 5%. All parameters are annual values. To answer this question, follow the three steps as described below. (a) Determine the stock and bond holdings of the replicating portfolio for the put. Do not round these holdings at less than 5 decimal places. (b) Now, suppose that the price jumps up to $- $105 instantaneously. Compute how the value of the replicating portfolio above changes. (c) Finally, compute the true new value of the put option, assuming that the Black-Scholes model is satisfied again from now on. What is the hedging error, i.e., the absolute value of the difference between the new value of the put option in (c) and the value of the replicating portfolio in (b)? Use 3 decimal places for your answer. Consider a put option on a stock with exercise price K = $90 and maturity T - 1 year. The stock's current price is S = $100, the volatility is o = 20%, and the dividend yield is q = 3%. The risk-free rate is Rp = 2%, and the expected (price) return of the stock is μ = 5%. All parameters are annual values. To answer this question, follow the three steps as described below. (a) Determine the stock and bond holdings of the replicating portfolio for the put. Do not round these holdings at less than 5 decimal places. (b) Now, suppose that the price jumps up to $- $105 instantaneously. Compute how the value of the replicating portfolio above changes. (c) Finally, compute the true new value of the put option, assuming that the Black-Scholes model is satisfied again from now on. What is the hedging error, i.e., the absolute value of the difference between the new value of the put option in (c) and the value of the replicating portfolio in (b)? Use 3 decimal places for your answer.

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To solve this problem we can use the BlackScholes model to calculate the replicating portfolio for the put option a Replicating Portfolio The stock ho... View the full answer